Integration and demutualization of the Karachi Stock Exchange (KSE), the Lahore Stock Exchange (LSE), and the Islamabad Stock Exchanges (ISE) are perhaps the most important developments being discussed in our capital market.
Listed companies, also referred to as issuers, are a core stakeholder in stock exchanges, along with investors and members of stock exchanges. This is why they would be keenly interested in these developments and their implications.
The objective here is to explain, in very simple terms, the concept of integration and demutualization and their potential advantages and disadvantages to listed companies.
The concept of integration of stock exchanges is intuitional. You can think of it as merger of the three stock exchanges into a single exchange. Demutualization means converting an exchange from a not-for-profit membership-based company into a for-profit company limited by shares, like a listed company. Integration and demutualization are likely to result in a large, well governed and dynamic securities exchange that can act as an effective economic agent.
Integration and demutualization can happen in more than one way. To keep things simple, let's take the scenario in which the KSE, the LSE, and the ISE merge into a single exchange that is a for-profit company listed on itself. In this scenario, issuers of listed securities can expect seven major advantages from integration and demutualization.
One, the monetary cost of listing should reduce. Of the total 670 listed companies, four out of five are listed at more than one exchange and one out of three is listed at all three exchanges. These listed companies have to pay listing fees to each exchange separately. Once there is only one exchange, only one fee would have to be paid.
Two, the managerial cost of time and effort spent in compliance with listing regulations should reduce. Companies that are listed at more than one exchange have to comply with the regulations of each exchange.
For instance, each corporate announcement has to be made to each exchange separately. Similarly, at the time of listing, a lot of paper-work for each exchange has to be done independently. When there would be only one exchange, compliance would be simplified.
Three, the number and quality of products and services for the issuers should improve. Once the KSE, the LSE, and the ISE integrate then the Central Depository Company (CDC) and National Clearing Company (NCC) shall become the subsidiaries of the integrated exchange.
All services, from listing, trading, custody, and settlement shall be provided by one exchange or its subsidiaries and exchange would have adequate economic and human resources to improve its services to issuers.
For example, it could facilitate development of market for debt securities making it easier for issuers to raise capital through debt instruments. Similarly, it could fasten the pace of issuing right shares. There would also be strong incentive for the exchange to act as a highly efficient share-registrar through the CDC for all listed companies.
Four, integration and demutualization should improve price discovery and liquidity in listed securities and broaden the investor base to the advantage of issuers. Since trading would take place at only one exchange, rather than three exchanges, there would be a single price for a security at any one point in time.
Trading volumes would increase because all the trading would happen at one exchange rather than three exchanges. Since exchanges earn most of their revenues from trading volumes, a for-profit exchange shall have a strong incentive to invest in having brokers and trading terminals in all those parts of the country which do not have direct access to the market.
Improved liquidity and price discovery and a broader investor base would make it easier for new companies to raise longer term risk-capital from the capital market and reduce their reliance on conventional lenders like banks. Companies would also be able to rely more on their stock prices to judge their performance.
Five, the exchange should be better able to understand the point of view of listed companies. The exchange would be both a listed company and the front line regulator of the listed companies.
It would be under constant pressure to be a role model for others. This would make it more realistic in devising and implementing regulations for listed companies, such as the Code of Corporate Governance.
Six, due to its greater economic and strategic significance, the exchange shall be better able to lobby with the Government for the common issues facing listed companies. For instance, the exchange may effectively seek concessions for the listed companies, such as lower tax rates on corporate income and dividends.
There would be a strong commercial incentive for the exchange to seek such concessions because the more the listed companies, the greater would be the listing revenue and trading fees for the exchange.
Seven, listing on a high profile and closely watched exchange should carry an element of prestige and help the listed companies in their overall marketing efforts. By following better governance practices, such as a high level of on-going disclosure, listed companies should be able to get better terms from lenders and other business partners than similar unlisted companies.
